Here is an interesting thought. At the begining of the game Setzer is involved with the Empire. He seemed scared to even defy them and made mention of how he males good money off of them. Maybe this has something to do with it.

It could be that somehow when might of screwed the Empire over some where in the distant past and as punishment they disfigured him for some reason. Maybe after the fateful airship crash and loosing his lover he went a little on the crazy side and tried to screw some Empire Soldiers over and either after cheating the Empire was punished.

Or since he is such a gambling man, maybe he made a bet with someone and couldn't afford to pay out afterwards, basicly he wrote a check his *** couldn't cash. So his payment was taken out on him.

I wonder if the scars are limited to his face alone or if they are full body.